Pension Reform in 2005
At the beginning of 2005, earnings-related pensions underwent the most extensive reform in their then 40-year history. It affected nearly all new pensions starting after the reform took effect.
The most important mile stones in the preparations of the 2005 pension reform were the November 2001 agreement of the labour market organisations and the September 2002 supplementary agreement. In November 2001, agreement was reached on the principle policies, while the determining of pensions was agreed on in September 2002. In that agreement, the most crucial issue was that the pensionable earnings were to be determined on the basis of the earnings throughout the entire working career.
Prior to reaching agreements, the decision-makers of the earnings-related pension scheme, i.e. the labour market organisations, had prepared the reform for a long time in the negotiation group of the labour market central organisations.
The goals of the reform
The aims of the reform was to postpone the average effective retirement age by 2-3 years and to adjust the pension scheme to the average increase in life expectancy. At the same time, the prerequisites for the 2007 consolidation and simplification of the earnings-related pension acts applied to private-sector employees were created.
Prior to 2005, the general old-age retirement age was 65 years. As of the beginning of 2005, it is possible to retire flexibly on an old-age pension between the ages of 63 and 68. Each and every one can decide for him or herself whether to retire at 63 or to continue working.
A person who has reached the age of 62 may retire on an early old-age pension. Early retirement reduces the pension permanently. A person retiring on old-age pension at the age of 63 will receive the accrued pension amount adjusted with the life expectancy coefficient.
Public-sector individual lower occupational and graded retirement ages selected in the 1990s remain valid after the 2005 reform. Linked to these lower retirement ages is the possibility to receive an early old-age pension prior to the age of 62.
In connection with the 2005 reform, the individual early pension is abolished as pension type. Some amendments are also made to the determination of pensions.
Individual early retirement pension
Only wage earners and self-employed persons born before 1944, and under certain conditions also municipal employees born between 1944 and 1947, are entitled to individual early retirement pension.
Although this pension type is abolished, the possibility to grant a disability pension under the same criteria as the individual early retirement pension for those who have turned 60 is enacted in the law.
More lenient terms and conditions are applied to disability applications by persons born in 1944 or later as of age 60.
The primary alternative to disability pension is vocational rehabilitation. As a result of the reform, the insured are entitled to the right to vocational rehabilitation if their illness, handicap or injury threatens to cause incapacity for work within approximately five years and if vocational rehabilitation within the earnings-related pension scheme is feasible.
The earnings that form the basis for the projected pensionable service that is related to disability pensions are now determined based on the earnings during the last five years. The accrual percentage for projected pensionable service was set at 1.3 per cent for persons aged 50-63.
The disability pension of young people is increased depending on age once the pension has continued for 5 years. The highest increase in the 2005 act was 21 per cent.
If an employee becomes disabled after the age of 63, he or she will be granted only old-age or part-time pension.
Disability pensions are determined as described above when the pension contingency occurs in 2006 or later.
Unemployment pension is abolished as pension type. The lower age limits for part-time pension and early old-age pension are raised to 58 and 62 years.
The unemployment pension ceases at the beginning of 2005 for those born in 1950 or later. The unemployment pension is replaced by the unemployment allowance, so-called additional days. Changes in pension acts do not affect unemployment pensions that began prior to 2006.
To receive the additional days of the unemployment benefit, the person must have turned 59 years and have a five year employment history during the preceding 15 years. The right to additional days continues until the age of 65, but at the age of 62, the person in question can select either the unemployment allowance or old-age pension. If the selection falls on the latter, no abate for early retirement is made to the old-age pension.
For people born before 1950, the requirements for unemployment pension continue to be 60 years of age and long-term and permanent unemployment. In addition, for those born before 1945, protective rules apply, thanks to which the requirements for unemployment pension remain unchanged.
The lower age limit for those born in 1947 or later is 58 years. The old-age pension accrual rate from the decrease in income dropped to 0.75 per cent, half of the previous accrual rate. For part-time work, pension accrues according to the regular pension accrual rates, i.e. at 1.9 and 4.5 per cent.
For those born in 1946 or earlier, the lower age limit is 56 years. Old-age and disability pension accrues from the decrease in earnings as before, at 1.5 per cent. Pension accrues for part-time work as according to previous rules, at 1.5 and 2.5 per cent. However, those born in 1946 or earlier can retire flexibly at age 63 without an abate for early retirement and without an integration of pensions.
Early old-age pension
After the reform, a person who has reached the age of 62 may retire on an early old-age pension. In that case, the pension is permanently reduced by 0.6 per cent per month. At its most, the abate for early retirement may reduce the old-age pension by 7.2 per cent (12 x 0.6).
The lower age limit for early old-age pension remains at 60 years for private-sector employees born in 1944 or earlier. Persons born before 1947 and working in the public sector, with five or less years to their old-age retirement age in 2004, may retire on an early old-age pension at any time. The abate for early retirement is 0.4 per cent for each month taken early, calculated from the individual old-age retirement age.
If a public-sector employee born before 1960 has more than five years to the old-age retirement age in 2004, he or she can retire on an early old-age pension three years prior to the individual retirement age. The abate for early retirement is 0.6 per cent for each month taken early.
Public-sector employees who have selected an occupation-specific retirement age may retire on an early old-age pension at age 62 at the earliest.
After the pension reform in 2005, earnings-related pension accrues now more favourably both at the beginning and the end of the insured’s working life. The previous lower limit for pension accrual of 23 years is now 18 years.
The earnings-related pension is calculated on the basis of all earnings throughout the insured’s working life. Earnings reduced by the earnings-related pension contribution are adjusted with the wage coefficient from the wage coefficient level of the year of earning to the level of the year in which the pension starts.
Pension provision earned before 2005 is calculated in advance into the accrual register according to rules in force before 2005.
The accrual rate is linked to the insured’s age. Earnings-related pension accrues at an annual rate of 1.5 per cent between the ages of 18 and 52. The older cohorts are encouraged to continue at work with an accrual rate of 1.9 per cent between the ages of 53 and 62 and as much as 4.5 per cent between the ages of 63 and 68. The new accrual rates are not implemented in retrospect.
However, for those born before 1950, public-sector pension accrues at a rate of 2 per cent of the annual earnings up to the 63rd birthday. After that, the accrual rate is 4.5 per cent.
A person on an old-age pension may start in a new employment. New pension is accrued at a rate of 1.5 per cent of the annual earnings. This component of the pension is paid as of the age of 68.
Pension accrues also for studies leading to a degree and for the parenthood allowance.
As of the beginning of 2005, pension accrues based on earnings. Various earnings-related social benefits are also taken into consideration according to the amount of earnings that the benefits are based on. The concerned benefits include
- unemployment, parenthood, adult training, rehabilitation and sickness allowances
- compensation for loss of income paid on the basis of motor liability and workers’ compensation insurance
- job alternation compensation.
No pension accrues for minimum level benefits, with the exception of the parenthood allowance.
When calculating the accrued pension, 75 per cent of the earnings that the unemployment allowance and the job alternation compensation is based on is taken into account. For other benefits, 65 per cent of the earnings that the benefit is based on is taken into account.
The parenthood allowance constitutes an exception in this respect. The earnings that the parenthood allowance is based on are raised to 117 per cent when calculating the pension accrued for the period during which the parent receives the parenthood allowance.
The parenthood allowance is exceptional also in that it is taken into consideration even for the period that it is paid to the employer: 17 per cent of the earnings that the allowance is based on is taken into account when calculating the pension.
Pension accrues also for
- the child home care allowance paid until the child turns three years if the parent takes care of the child him or helself, and
- studies for 3-5 years if they have led to a degree.
Both accrue pension on the basis of a computational monthly income which corresponds to about one fourth of the national average wage. The State finances the benefit.
Pension accrues annually at the rate of 1.5 per cent of the earnings on which social security benefits are based.
Factors affecting the earnings-related provision of the young include a change in the lower age-limit for insurance coverage and insurance accrual for periods of study.
Earnings-related pension accrues for all work done between the ages of 18 and 68. Previously, the lower age limit was 23 years.The obligation to take out an earnings-related insurance has thus also risen to 18 years. Employers do not have to insure employees who are younger than that. Previously, pension insurance had to be taken out for all aged 14 and above.
Earnings-related pension accrues also for periods of study. Pension provision for periods of study is a benefit that was introduced in connection with the 2005 pension reform. Pension accrues for three to five years, depending on the level of the degree. The earnings that the benefit is based on is a computational monthly wage of EUR 694.83 (in 2013).The benefit is financed by the State. The prerequisite for receiving this benefit is that the studies have led to a degree.
A lump-sum increment is added to the pension of a person who has begun drawing a disability pension when under the age of 50. The increment is added once the person has drawn the pension for five years. The higher the increment the younger the person was when retiring on a disability pension. The increment improves the pension level of the young which is often very modest due to small earnings. There was no equivalent increment prior to the 2005 pension reform.
The accrual percentage increases pronouncedly with age. Work done after the age of 63 compensates considerably for any disruptions in the early stages of the career and thus raises the low pension rate. However, low earnings at the initial stages of the working career affect the pension calculated on the basis of the earnings throughout the entire working career.
The life expectancy coefficient is a mechanism affecting the pension amount and used to hold in check the pension expenditure due to a prolonged life expectancy. The coefficient is based on the average length in life expectancy calculated on the basis of the mortality rates for the preceding five years. The coefficient is determined annually for those who have turned 62 years.
According to the 2005 legislation, the life expectancy coefficient is applied to all starting old-age pensions and to the surviving spouse’s pension at the point when the pension would be reduced based on the surviving spouse’s own pension income. The life expectancy coefficient affected pensions for the first time in 2010 and concerned persons born in 1948 and later.
The earnings-related pension is calculated in relation to the earned wages. The annual wages are converted to correspond to the level at the time of calculation. The amounts are converted by multiplying the old wages with the wage coefficient.
The wage coefficient is determined on the basis of the annual change of the wage and price level. In the coefficient, changes in wages weigh 80 per cent and changes in consumer prices 20 per cent.
The earnings-related pension index helps to retain the value of earnings-related pensions in payment. Pensions are raised according to the change in index at the beginning of January each year. The earnings-related pension index is determined on the basis of the annual change of the wage and price level. The weight of changes in earnings is 20 per cent and in changes of consumer prices 80 per cent.
The Ministry of Social Affairs and Health annually confirms the wage coefficient and the earnings-related pension index based on calculations by the Finnish Centre for Pensions.
Prior to 2005, there were two indexes. The indexes were linked to the age. The 2005 reform abolished this much criticized age-dependency. Now wages are raised according to the wage coefficient and all pensions according to the earnings-related pension index.
All pensions in payment are adjusted with the earnings-related pension index as of the beginning of 2005. When determining the pension, the former fifty-fifty index was used in certain cases until 2012.
Vocational rehabilitation became a statutory earnings-related pension benefit at the beginning of 2004. The rehabilitee receives a rehabilitation allowance which is always higher than the mere disability pension.
A rehabilitee on a disability pension receives a rehabilitation increment on top of the pension. The rehabilitee may also receive a discretionary rehabilitation assistance.
Rehabilitation within the earnings-related pension scheme is intended for those in working life. Therefore the prerequisite for rehabilitation within the earnings-related pension scheme is that the rehabilitee has fulfilled a certain earnings requirement during the five previous calendar years. This type of rehabilitation is financed by the earnings-related pension institutions. Kela, on the other hand, arranges vocational rehabilitation for those outside working life or those who have only recently entered working life.
The unconditional criterion for rehabilitation is the threat of disability which can be postponed or prevented with appropriate rehabilitation. Rehabilitation is used to support an individual’s continued working. The possibilities for rehabilitation are always investigated before issuing a disability pension decision.
The initiative to rehabilitation may come from the individual, the supervisor, occupational health care or personnel management. Rehabilitation within the earnings-related pension schemes begins as such with a rehabilitation application.
The rehabilitation is always individual and vocational. It is planned according to the needs of the applicant. The starting point for rehabilitation is cooperation with the workplace. First, the possibility for new work arrangements are investigated.
Vocational rehabilitation may include counselling, work trials, work training, retraining or financial assistance to become self-employed.
The same rules apply for the self-employed and farmers.
Due to the 2005 earnings-related pension reform, the insurance contribution varies according to age. Employees aged 53 or above pay a contribution that is nearly 30 per cent higher than that paid by younger employees.
On the other hand, the pension accrual rate for those aged 53-62 is higher than for those aged under 53; for those aged 63, as much as three times higher. The older generations thus participate, for their part, in the accrual of their higher pension provision.
Employees have paid part of the earnings-related insurance contributions since 1993. Changes to the contributions are divided equally between the wage earners and the employers.
As of 2005, a self-employed person may pay a higher contribution under the Self-employed Persons’ Pensions Act in good times and a smaller one in tougher times, without changing the permanent contribution. The use of the flexible contribution does not affect the amount of the confirmed earnings, but it affects the pension that is accrued.
The increased contribution must be at least 10 per cent higher than the permanent contribution. The increase may not be higher than the permanent contribution, in which case pension accrues twice as much as when the regular contribution is paid. The self-employed may pay an increased contribution every year.
The contribution can be reduced by a maximum of 20 per cent of the permanent contribution. The reduction may be used during three calendar years per seven consecutive calendar years. In general, the combined permanent and increased contribution may not exceed the contribution for the maximum annual YEL earnings for the year in question.
The lower YEL income limit changes annually due to the changes in the wage coefficient. The flexible contribution may not be smaller than the contribution for the lower income limit for the year in question.
Flexible contributions are not possible for
- the self-employed who have turned 63 years
- a retired self-employed person
- a self-employed person who receives a contribution discount for a starting self-employed person, or
- a self-employed person who has unpaid YEL contributions.
Background Studies and Impact Assessments of 2005 Pension Reform
The Finnish Centre for Pensions has made background studies relating to the development of pensions, both on its own initiative and on the initiative of its Board of Directors, the labour market work group, the Ministry of Social Affairs and Health and Parliament. Other parties have also made impact assessments of the 2005 pension reform.
According to calculations made it would seem that, for example, the improved accrual rates, the linking of earnings and income from work that form the basis of pensions to the wage coefficient, and the expected prolonging of working careers will raise the pension level. An expansion of the age limits between which pension accrues and an accelerated accrual rate to encourage continuing in employment would prolong working careers.
Changes leading to an improved pension level include also the removal of the integration of earnings-related pensions to a 60 per cent limit, as well as the increasingly extended pension entitlement and accrual rate for various unpaid periods.
After the reform, the projected pensionable service granted to the pension will also result in a higher accrued pension than before the reform, and the number of persons entitled to this benefit has increased. On the other hand, after the reform, it is possible to receive an old-age pension in full as of the age of 63, so the projected pensionable service is calculated until the age of 63 instead of 65.
The reform also includes changes that reduce the pension level. In the new scheme, pensions are determined on the basis of the insured person’s average earnings during his or her total career rather than during the last few years. The resulting effect of reducing the pension level is evened out by the fact that the earnings during the career are adjusted with a wage coefficient rather than the fifty-fifty index.
As of 2005, all pensions in payment are adjusted with the earnings-related pension index. Previously, the pensions of those under the age of 65 were adjusted with the fifty-fifty index. For persons who have been disabled at a young age, the change is evened out by the increase made after the person has drawn a disability pension for five years. Depending on the age of the pension recipient, the maximum increase is 21 per cent.
The life expectancy coefficient that affects old-age pensions as of 2010 will reduce the amount of the monthly paid pension, but it does not reduce the pension accrual paid for the entire retirement period if the pension recipient reaches the age according to the life expectancy. Furthermore, by prolonging the working career with a fairly short period of time, the pension recipient can compensate the reducing effect of the life expectancy coefficient on the pension accrued at a certain age.
The pension reform evens out pension gaps between men and women
Based on a request by the Ministry of Social Affairs and Health, a survey of the gender impacts of the 2005 earnings-related pension reform has been performed. For the first time, an assessment of gender impacts was linked to a government bill in connection with the reform of the private-sector earnings-related pension acts. According to this assessment, the reform secures a functioning scheme in terms of its equality impacts.
The surveys and calculations produced for the law-drafting showed that the new model of the average earnings during a career does not cause gender inequality. Nor does it include any singular features that would be problematic in terms of gender equality.
In the long run, taking into account the reforms regarding unpaid periods and the impact on employees’ pension provision of the amendments made to the National Pensions Act, the reform will even out the pension gap between men and women.
- Eila Tuominen, 2004. Gender Mainstreaming in the Finnish Pension Reform 2005, Finnish Centre for Pensions, Working Papers 10.
Pension based on average earnings during career
As of 2005, the pension is calculated based on the earnings and accrual rate for each year. An employment-specific calculation model that takes into account the last ten years was renounced.
The former method excluded the years – perhaps of low earnings – preceding the last ten years from the calculation. This form of calculation model favours long employment relationships, in which the best earnings level occurs during the last ten years. The calculation model was unfavourable for such persons whose career consisted of shorter employments and who had gained their highest earnings during a younger age.
When preparing the pension reform, the issue of the pensionable earnings was one of the most difficult problems. To facilitate the solution, the Finnish Centre for Pensions performed an extensive survey on pensionable earnings.
Life expectancy coefficient to regulate the increase in pension expenditure due to an extended life expectancy
In the early 2000s, surveys were conducted on the extended life expectancy and on the possibilities to take it into consideration in the earnings-related pension scheme.
- Lindell Christina, 2004. Longevity is increasing – what about the retirement age?, Finnish Centre for Pensions, Working Papers 6.
- Juha Alho, 2003. Predictive Distribution of Adjustment for Life Expectancy Change, Finnish Centre for Pensions, Working Papers 3. (pdf)
Tightening of early retirements increase the number of working years of the elderly
Due to the large numbers of disability pensions, the largest increase to the years of working by the pension reform is due to the abolishment of the unemployment pension and the raise of the lower age limit for the right to unemployment allowance for additional days. As a result, the ratio of new unemployed elderly will decrease and employment increase.
An increase in the lower age limit for part-time pension and early old-age pension will also support continued working. Abolishing the individual early retirement pension has a similar affect, although it is numerically smaller.